Thursday, July 26, 2007

While I've had issues with material on the Wall Street Journal's editorial
page, and today is no exception, I want to be careful to separate what goes on
there from what gets presented elsewhere in the WSJ.

David Wessel's Capital column is not on the editorial page, and it
does not belong there. I don't always agree with everything he says, and I don't always disagree
either, but I never get the impression that facts are twisted to sell a
preconceived notion:

But a recent study on globalization, commissioned by the Financial Services
Forum, an association of the chief executives of 20 huge financial companies,
ranging from American International Group and Citigroup to UBS and Wachovia,
stands out.

The analysis, written by a former member of President Clinton's Council of
Economic Advisers, a former member of President Bush's and a former Bush
Commerce Department official, says:

(1) Globalization is good for the U.S. economy. (No surprise coming from a
bunch of financial firms that make money doing business across borders.)

(2) Gains from globalization aren't evenly shared. (A little surprising, but
in the past couple of years, there has been a willingness among business to
publicly acknowledge that economic reality.)

(3) To avoid a backlash against globalization, governments and businesses
must come up with new ways to spread its benefits more widely and assist those
hurt by all sorts of economic change. (Very surprising, more like a Democratic
candidate's talking points than a report issued and promoted by an outfit led by
Citigroup Chief Executive Charles Prince and Don Evans, the former Bush commerce
secretary.

What's Going On? Business interests with a strong stake in globalization ... see rising public anxiety about globalization as a threat. And they
realize that preaching the gospel of comparative advantage isn't going to win
the debate.

"The mounting opposition is in response to the other side of globalization --
outsourcing of jobs, economic dislocation, anxiety and fear," the forum said ... early this year. "Making the case for trade and
globalization requires...a list of specific, meaningful, practical,
cost-efficient, and effective public- and private-sector responses to the
reality that while the aggregate benefits of free trade and globalization are
tremendous, it can sometimes bring with it painful dislocations for individuals,
families, towns, regions, even entire industries." ...

Some business executives, prodded by politicians such as House Ways and Means
Chairman Charles Rangel, finally are realizing that trade-friendly Democrats
will be overwhelmed by trade skeptics unless there is something tangible to
offer workers worried about their livelihoods and their children's. A new Pew
Global Attitudes survey finds Americans generally optimistic about the next five
years, but only 31% expect their children's lives will be better than their own;
Europeans are even more pessimistic. By contrast, 81% of the Chinese expect
their children to do better.

The Financial Services Forum report is, in part, a response to that. The
specifics are intriguing ... because they move beyond inadequate approaches such
as making the failing Trade Adjustment Assistance program for dislocated workers
a tad more generous.

Among the Proposals: Raise taxes on winners to share benefits of
globalization more widely. Replace TAA and unemployment insurance with a big new
program for displaced workers that offers wage insurance to ease the pain of
taking a lower-paying job. Provide for portable health insurance and retraining.
Create a way for communities to ensure their tax base against big factory
closures. Eliminate tax hurdles for businesses that do what International
Business Machines is proposing: Offer 50 cents for every $1 (up to $1,000 a
year) that workers set aside to pay for training. ...

Grant Aldonas of the Center for Strategic and International Studies think
tank, one of the report's three authors [said] "...We are renegotiating the
social contract in America, but we're letting it be done by the United Auto
Workers and Delphi, and leaving a lot of others out -- including the poor and
the businesses on the leading edge."

Mr. Aldonas and his co-authors, Dartmouth's Matthew Slaughter and Harvard's
Robert Lawrence, ... say the U.S. need not accept as inevitable the
steady widening of the gap between economic winners and losers, an inequality
that threatens to produce barriers to trade, investment and immigration that
will hurt U.S. prosperity. ...

Now the question is whether business will go beyond talk. As C. Fred Bergsten
... puts it: "They haven't gone to the mat and talked to Charlie Rangel and
Democrats who are wavering, if not worse, and said, 'We want to support a
meaningful program of wage insurance, and we'll be willing to give up some of
our beloved tax breaks to pay for it.' "

One troubling sign: Although forum chief executives issued statements
blessing the new report, not one has been willing to talk to a Wall Street
Journal reporter about it.

One thing that bothers me about the whole inequality debate is the
presumption that the winners deserve their incomes because it reflects their
contribution to the firm, i.e. it is the wage that would be earned in
well-functioning competitive markets, with the reward is equal to the person's marginal
contribution to the firm. Thus, the analysis often begins with the idea that any tax takes away someone's hard-earned income and redistributes it elsewhere.

But for the incomes where inequality is rising most -
those at the very top of the income distribution - this is a questionable claim. The
idea that the salary of a CEO or hedge fund manager is set by competitive markets, or even
approximately so, seems unlikely, or at least open to serious question. It should not
just be assumed in these debates.

If the incomes of the winners are higher than they would be in a competitive
market, then many of the arguments against taxing their "hard-earned money" melt
away. For example, if a person would earn $1,000,000 in a competitive market,
but because of market imperfections earns $1,200,000 instead, is it unfair to
tax away the extra $200,000?

At a 33% tax rate in a competitive market, after-tax income would be $667,000, i.e. the competitive income of $1,000,000
minus 33%. At the non-competitive income of $1,200,000, it would take a tax rate of around 44% to
leave the person equally well off (i.e. $1,200,000 - 44% of $1,200,000 = approx. $667,000).

For this reason, I would argue that tax rates such as the 44% rate in this example are not as high as they might seem. Part of the tax simply levels the playing field, i.e. taxes away the income in excess of the competitive level, and the tax rate is then 33%, not 44%, on the part of income that would be earned in a competitive market.

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David Wessel: Globalization Study Moves Past Rhetoric

While I've had issues with material on the Wall Street Journal's editorial
page, and today is no exception, I want to be careful to separate what goes on
there from what gets presented elsewhere in the WSJ.

David Wessel's Capital column is not on the editorial page, and it
does not belong there. I don't always agree with everything he says, and I don't always disagree
either, but I never get the impression that facts are twisted to sell a
preconceived notion:

But a recent study on globalization, commissioned by the Financial Services
Forum, an association of the chief executives of 20 huge financial companies,
ranging from American International Group and Citigroup to UBS and Wachovia,
stands out.

The analysis, written by a former member of President Clinton's Council of
Economic Advisers, a former member of President Bush's and a former Bush
Commerce Department official, says:

(1) Globalization is good for the U.S. economy. (No surprise coming from a
bunch of financial firms that make money doing business across borders.)

(2) Gains from globalization aren't evenly shared. (A little surprising, but
in the past couple of years, there has been a willingness among business to
publicly acknowledge that economic reality.)

(3) To avoid a backlash against globalization, governments and businesses
must come up with new ways to spread its benefits more widely and assist those
hurt by all sorts of economic change. (Very surprising, more like a Democratic
candidate's talking points than a report issued and promoted by an outfit led by
Citigroup Chief Executive Charles Prince and Don Evans, the former Bush commerce
secretary.

What's Going On? Business interests with a strong stake in globalization ... see rising public anxiety about globalization as a threat. And they
realize that preaching the gospel of comparative advantage isn't going to win
the debate.

"The mounting opposition is in response to the other side of globalization --
outsourcing of jobs, economic dislocation, anxiety and fear," the forum said ... early this year. "Making the case for trade and
globalization requires...a list of specific, meaningful, practical,
cost-efficient, and effective public- and private-sector responses to the
reality that while the aggregate benefits of free trade and globalization are
tremendous, it can sometimes bring with it painful dislocations for individuals,
families, towns, regions, even entire industries." ...

Some business executives, prodded by politicians such as House Ways and Means
Chairman Charles Rangel, finally are realizing that trade-friendly Democrats
will be overwhelmed by trade skeptics unless there is something tangible to
offer workers worried about their livelihoods and their children's. A new Pew
Global Attitudes survey finds Americans generally optimistic about the next five
years, but only 31% expect their children's lives will be better than their own;
Europeans are even more pessimistic. By contrast, 81% of the Chinese expect
their children to do better.

The Financial Services Forum report is, in part, a response to that. The
specifics are intriguing ... because they move beyond inadequate approaches such
as making the failing Trade Adjustment Assistance program for dislocated workers
a tad more generous.

Among the Proposals: Raise taxes on winners to share benefits of
globalization more widely. Replace TAA and unemployment insurance with a big new
program for displaced workers that offers wage insurance to ease the pain of
taking a lower-paying job. Provide for portable health insurance and retraining.
Create a way for communities to ensure their tax base against big factory
closures. Eliminate tax hurdles for businesses that do what International
Business Machines is proposing: Offer 50 cents for every $1 (up to $1,000 a
year) that workers set aside to pay for training. ...

Grant Aldonas of the Center for Strategic and International Studies think
tank, one of the report's three authors [said] "...We are renegotiating the
social contract in America, but we're letting it be done by the United Auto
Workers and Delphi, and leaving a lot of others out -- including the poor and
the businesses on the leading edge."

Mr. Aldonas and his co-authors, Dartmouth's Matthew Slaughter and Harvard's
Robert Lawrence, ... say the U.S. need not accept as inevitable the
steady widening of the gap between economic winners and losers, an inequality
that threatens to produce barriers to trade, investment and immigration that
will hurt U.S. prosperity. ...

Now the question is whether business will go beyond talk. As C. Fred Bergsten
... puts it: "They haven't gone to the mat and talked to Charlie Rangel and
Democrats who are wavering, if not worse, and said, 'We want to support a
meaningful program of wage insurance, and we'll be willing to give up some of
our beloved tax breaks to pay for it.' "

One troubling sign: Although forum chief executives issued statements
blessing the new report, not one has been willing to talk to a Wall Street
Journal reporter about it.

One thing that bothers me about the whole inequality debate is the
presumption that the winners deserve their incomes because it reflects their
contribution to the firm, i.e. it is the wage that would be earned in
well-functioning competitive markets, with the reward is equal to the person's marginal
contribution to the firm. Thus, the analysis often begins with the idea that any tax takes away someone's hard-earned income and redistributes it elsewhere.

But for the incomes where inequality is rising most -
those at the very top of the income distribution - this is a questionable claim. The
idea that the salary of a CEO or hedge fund manager is set by competitive markets, or even
approximately so, seems unlikely, or at least open to serious question. It should not
just be assumed in these debates.

If the incomes of the winners are higher than they would be in a competitive
market, then many of the arguments against taxing their "hard-earned money" melt
away. For example, if a person would earn $1,000,000 in a competitive market,
but because of market imperfections earns $1,200,000 instead, is it unfair to
tax away the extra $200,000?

At a 33% tax rate in a competitive market, after-tax income would be $667,000, i.e. the competitive income of $1,000,000
minus 33%. At the non-competitive income of $1,200,000, it would take a tax rate of around 44% to
leave the person equally well off (i.e. $1,200,000 - 44% of $1,200,000 = approx. $667,000).

For this reason, I would argue that tax rates such as the 44% rate in this example are not as high as they might seem. Part of the tax simply levels the playing field, i.e. taxes away the income in excess of the competitive level, and the tax rate is then 33%, not 44%, on the part of income that would be earned in a competitive market.